July 20 - 26, 2009

An expectation of cutback in the discount rate in the next quarter monetary policy is restoring the confidence of private sector. In the expectation of loosening monetary policy, Karachi interbank operating rate, a benchmark of lending mark-up, has started to move on downward track. This rate for different terms loans has witnessed a decline after about one year, reflecting a possible reduction of 100 to 200 basis points in the benchmark interest rate. State bank of Pakistan (SBP) would reduce rate by one to two percent in its transactions with the financial institutions, to this effect. In the times of high cost of funding, not only acquiring capital from financial institutions become costly but also running finances receive a deteriorating affects that put brakes on financial cycle of industries. Based on floating rate, cost of acquiring working capital is high when discount rate pushes up interest rate. Contraction in industrial production has enhanced credit risk significantly. It is obvious that underperforming corporate sector falls short of debt obligations.

Non-performing loans are rising in Pakistan. NPLs exhibited an increase of 21 percent during Jan-March over the last quarter. Net NPLs to net loans ratio increased to 3.96 percent as of March while it was 3.53 percent in the same month last year. SBP's quarter ending March data recorded an increase in net NPLs of all banks and development financial institutions (DFIs) to Rs121 billion from Rs114 billion last year. Until March, banks recovered cash against NPLs of Rs11.54 billion, while by the same month last year they recovered Rs12.38 billion. Local private banks had large impaired amounts by the end of March, depicting Rs68 billion as NPLs. They had Rs61 NPLs until March last year.

Financial analysts see this trend threatening to growth of assets of the banking sector. Assets of banks grew passively by 1.6 percent in the quarter. Advances have decreased substantially since the exposure to the government securities increased thanks to one-year consistent hike in discount rates. Government should rise up to curb the further deceleration in private credit growth. There was catch phrase revolving around the financial circle at the time of last monetary policy announcement that an insolvency law was on the anvil. Corporate Rehabilitation Act to be introduced by July would help recession-hit companies to revive or give mandate to corporate regulator to take over insolvents, Bloomberg quoted Chairman Securities and Exchange Commission of Pakistan as saying.

The global economic and financial crises have increased the concern about rising non-performing loans also called nonaccrual or bad debts. This led to renewed interest in defining the incorporation of NPLs in to macro economic statistics. IMF study on treatment of bad debts in macro economic statistics, released in 2007, was acknowledged for providing a key guideline in this regard. The salient point asserted the need for valuation of loans to be consistent with the debtor's legal obligations. While all commercial banks and creditors adhere to this common guideline, the insolvency risks increase when financial institutions want to capitalize on economies of scale without perhaps contingency plan to counteract backfire. Wide penetration of loans deluded banks into believing repayment would be easy. Deplorable is the fact that most of the developed economies suffered from this delusion. China has seen enormity of impaired. Financial crisis and economic slowdown making debtors vulnerable to insolvency are leading causes, but negligence in making contingency plan that could have reduced provisioning costs can not be ignored.

The central bank in Pakistan slashed discount rate to 14 percent in April as inflation was sliding back to single digit. Government is expected single digit inflation in this fiscal year. By June, it stood at 13.1 percent. Current account deficit dropped to $8.86 billion in FY09 from $13.86 billion in the FY08, down 36 percent. The country received record flow of remittances in last fiscal year and trade deficit was also shortened. Although government has not bagged third tranche of IMF $7.6 billion stand-by loan, substantial inflow of remittances and imports decline has refilled the foreign reserves to a secured level. However, government needs additional foreign flows to revive economic growth.

The government has applied for another loan from the International Monetary Fund (IMF). This would be besides an already sanctioned debt. Flexible credit line is what this new loan is reported in the media. Government is seeking this credit line to offset impact of non-arrival of over $5 billion pledged during a conclave of 'Friends of Democratic Pakistan'. The third tranche was expected in July. The flexible credit line (of $4 billion) would be used for social sector development and to work out growth-oriented policy, reportedly said Finance Adviser, Shaukat Tarin. "I cannot confirm $4 billion. I think a number of issues have been under discussion," said, Caroline Atkinson, Director, External Relations, at a media briefing in Washington.

The instability of macro economic fundamentals had encouraged banks to avoid taking risks with liquidity flows to the private sector. Insolvency had turned out another leading cause. Delinquency of debts is ingrained in both commercial and consumer portfolios. Persistent increase of interest rates caused defaults in commercial and corporate portfolios. Consumers were unable to pay back loans for different reasons. Consumer finance is sanctioned on fixed mark up, unaffected of rate revision after the loan sanctioning. High interest rate discourages growth of assets in consumer portfolio.

Possible cut in the discount rate would bring proportionate change in interbank rate. This is imperative to spur lending to private sector. The loan portfolio declined by 5.6 percent in Jan-March over the last quarter while investments in government papers increased by 20 percent, according to SBP quarterly performance review of the banking system.